Long-run Production Costs

Period of time long enough for firms to change the quantities of all resources employed including capital and new factories.

In the long run, there is no distinction between FC and VC because all resources (therefore costs) are variable in the long run

In the long run, an industry and the individual firms it comprises can undertake all desired resource adjustments or in other words, they can change the amount of all inputs used.

The long run allows sufficient time for new firms to enter or for existing firms to leave an industry.

Firm size and costsChange from small scale to large scale, ATC will decrease at first, but it increase after.

All resources and costs are variable

The long-run cost curve

The green, orange, yellow, pink, blue curves are separate short run curves. The long run curve is created by combining all the lowest ATC at any output of the short run curves.*If the number of possible plant sizes is very large, the long-run average-total-cost curve approximates a smooth curve. Economies of scale, folowed by diseconomies of scale, cause the curve to be U-shaped.

Economies and Diseconomies of ScaleEconomies of Scale: A firm achieves economies of scale when it is able to decrease the per unit cost of production (ATC) as output increases. This can be achieved through cost advantages such as:

Labor Specialization: as plant size increases, more workers are hired and labor becomes increasingly specialized. workers work fewer and fewer tasks and thus become more skilled at those tasks, and production is efficient

For example: Workers assemble specific parts of cars in an assembly line. Compared to many workers working on one car at a time, the assembly line is much more efficient.

Workers become more proficient in their specialized area, making him highly efficient in that one area.

Greater labor specialization eliminates the loss of time that comes with each worker's shift from one task to another.

Other: advertising costs fall per unit of output as more units are produced and sold. Production and marketing skills increase as the firm produces and sells more output. (learning by doing)

Example: The Daily Newspaper.Reporters, delivery trucks, photographers, editors, management, printers, and all the paper resources go into making a newspaper. However, in most large cities, this newspaper only costs 50 cents. The reason for this is that the fixed costs are spread out and that economies of scale is achieved. The large number of consumers allows the publisher to specialize labor and large printing presses.

Diseconomies of Scale: This is an increase in ATC as output increases. This is usually attributed to the difficulty of efficiently controlling and coordinating a firm's operations as it becomes a large-scale producer. (The beast becomes too big to handle!)

Overexpansion of management leads to:

Bureaucratic red tape

Miscommunication

Slower decision-making

Lower action in the face of changes in consumer tastes or technology

Workers are more inclined to slack or shirk if they are far removed or alienated from employers. This also leads to greater dissatisfaction with work. More costs are needed to hire more managers.

A good example of this is with General Motors. It became far too big to handle, and thus split into smaller, far more profitable companies such as Cadillac etc.

Constant Returns to Scale:

exist between where economies of scale end and diseconomies scale begin.

long run AC(average cost) does not change --> ATC range constant

5 types of Economies of Scale: 1. Managerial Economies of scale:The ability of a business to outsource and hire new people depending on its size2. Technological:The ability of a business to require new capital3. Marketing:The ability of a business to get discounts for supplies4. Financial:The ability to get loans from banks or use assets in order to purchase more technology5. Risk Bearing:The ability of a company to diversify

Minimum efficient scale and industry structure

Minimum efficient scale: lowest level of output at which a firm can minimize its long-run ATC. This is where economies of scale are reached and where, past this point, diseconomies of scale beging to appear. The shape of the LATC and where the MES lies determines the industry structure.

LATC1: Where economies of scale are reached quickly and where diseconomies of scale quickly begin, i.e. where MES is reached at a low level of input, the industry supports many small producers.

LATC2: Where economies of scale exist over a wide range and MES occurs only at high output, efficient production will only be achieved by a few very large firms. Smaller firms, unable to produce at small quantities efficiently, cannot compete. This can, in extreme cases, lead to a natural monopoly.

Examples: the aircraft, information technology and internet service provider industries.

A natural monopoly is a relatively rare market situation in which average total cost is minimized when only one firm produces the particular good or service.

LATC3: Where there is an extended range of constant returns to scale, many quantities produced have the same level of efficiency, allowing for many firms of different sizes to coexist.